We last wrote about the upcoming unfair contract terms reforms in our article 'The 'fairness revolution' continues: Government releases draft legislation extending unfair contract terms regime to insurance'.
With only 10 months to go until the unfair contract terms laws apply to insurance contracts, insurers and coverholders should prepare for implementation by undertaking a legal review of affected policies. While implementation of a number of reforms has been delayed by six months, the unfair contract terms laws have already passed Parliament.
ASIC was recently successful in the Federal Court in obtaining a declaration that terms within six small business loan contracts were unfair. In a media release, ASIC Commissioner Sean Hughes said 'Importantly, insurance firms should be preparing to extend these obligations in insurance contracts'.
Where are we now?
Amendments to the Insurance Contracts Act 1984 (Cth) (ICA) will allow the current unfair contract terms regime in the Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) to apply to insurance contracts subject to the ICA from 5 April 2021.1
The legislation as passed is virtually identical to the exposure draft, despite calls from insurers to further modify the application of the law to insurance contracts. The only change made is to provide an exemption for medical indemnity insurance products. Importantly, the definition of 'main subject matter' remains narrow. As a result, all terms of the insurance contract except for the description of what is being insured may be subject to challenge. Terms such as policy exclusions will almost always cause detriment if applied. The approach taken by the government does leave some uncertainty for insurers and consumers alike but the effects can be mitigated for the benefit of all stakeholders by removing or rewriting potentially unfair terms in insurance contracts and reviewing underwriting criteria.
What is the test for whether a term is 'unfair'?
Under section 12BF of the ASIC Act, a term of a 'consumer contract' or 'small business contract' is void if these three elements are met:
- the term is unfair;
- the contract is a standard form contract; and
- the contract is a financial product, or a contract for the supply, or possible supply, of financial services.
Although there was some guidance in the draft consultation materials, the government has not provided more clarity in relation to when an insurance contract ceases to be a standard form contract. An insurance contract can still be a standard form contract if a broker acts on behalf of the customer. However, brokers frequently seek specific endorsements on behalf of their clients. In some circumstances, these negotiated contracts may no longer be a standard form contract.
As a result of the new laws, it will be important for insurers who give binding authority to brokers to ensure this authority is properly exercised, and the customer is aware of who the broker acts for during any negotiation of the insurance policy terms.
What is the meaning of 'unfair'?
Under s 12BG of the ASIC Act, a term of a standard form contract is unfair if it:
- would cause a significant imbalance in the party's rights and obligations arising under the contract;
- is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
- would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.
A court must take into account all relevant matters, including the extent to which the term is transparent and the contract as a whole. A number of court decisions have also considered the meaning of 'unfair'.
Unlike the consultation draft, the final Explanatory Memorandum provides more examples of potentially unfair terms in the insurance context. These include but are not limited to terms that:
- allow the insurer to, instead of making a repair, elect to settle a claim with a cash payment calculated according to the cost of the repair to the insurer, rather than how much it would cost the customer to make the repair; and
- require the insured to pay an excess before the insurer pays the claim;
- contain unexpected payment arrangements;
- are outdated, inaccurate and restrictive medical definitions; and
- significantly reduce cover where compliance with the conditions which trigger cover are unfeasible.
What terms are protected?
However, not all terms of a contract are captured by the regime. The regime does not apply to terms of a contract that:
- define the main subject matter of the contract;
- set the upfront price payable under the contract;
- set the amount of an excess or deductible provided this is a transparent term; or
- is a term required, or expressly permitted, by a law of the Commonwealth or a State or Territory.
What should insurers and coverholders do?
Following the Royal Commission and throughout the COVID-19 pandemic so far, there has been renewed focus on ensuring customers are sold products of value to them. The government has also recently consulted on enhancements to the unfair contract terms regime and intends to introduce civil pecuniary penalties for including such terms in standard form contracts.
Insurers and coverholders should undertake legal review of affected policy wordings and may even need to engage with underwriters and actuaries where policy conditions and coverage need to be amended. Although unfair contract terms laws have been in place in the financial services industry for some time, insurance contracts operate differently and will continue to be subject to the ICA. A specific insurance-focused lens is therefore required when implementing these laws, keeping in mind other insurance regulatory changes which will come into effect at a later date.
1 Financial Sector Reform (Hayne Royal Commission Response-Protecting Consumers (2019 Measures)) Act 2020 (Cth).
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